Excellent Article on Offshore Accounts - History and Future (11/9/11)

Readers might be interested in a new article published this week in Tax Notes, Charles P. Rettig, Evaluation of an IRS Undisclosed Offshore Account IDR, 133 Tax Notes 759 (Nov. 7, 2011), here. I note the following.

1. Chuck Rettig is a leading practitioner in this area of practice and his articles are always worthy of note.

2. The article is a good summary of the history and current state of the offshore account problem and the IRS initiatives. Much of this discussion in the article is probably already known to readers of this blog.

3. Chuck correctly cites (p. 762 at fn 21) ILM 200603026 where an IRS author concludes that, in an FBAR willfulness penalty case, the Government would be required to prove willfulness by clear and convincing evidence. As I noted, however, in an earlier blog, the Court in the Williams case discussed in Chuck's article, held that the preponderance of the evidence standard applied. See Burden of Proof for Willfulness in FBAR Violations (9/6/11), here.  I agree that the clear and convincing standard should apply, but I think that Williams is the only court that has directly addressed the issue and reached another conclusion. I give my reasons for my conclusion in the cited blog. What the difference is between these standards may appear esoteric, but it is not. Clear and convincing is a burden that is greater than preponderance and lesser than beyond a reasonable doubt. In order to illustrate, I pull out two quotes from my most recent draft of my Federal Tax Crimes book (not yet published):

Playing the numbers game, Judge Jack B. Weinstein, certainly one of the deeper thinkers in this area, observed that the lesser clear and convincing standard of proof (the standard applicable in civil fraud matters such as a civil fraud penalty under § 6663) might be quantified as proof above 70%. See United States v. Copeland, 379 F. Supp. 2d 275 (ED NY 2005), aff’d United States v. Copeland, 2007 U.S. App. LEXIS 19794 (2d Cir. 2007), quoting United States v. Fatico, 458 F. Supp. 388, 411 (E.D.N.Y. 1978). Other thoughtful observers quantify the proof for “clear and convincing” at 75%. See Lewis Kaplow, Burden of Proof, 31 (to be published by Yale Law Journal (2012), but appearing in draft form dated 8/15/11 at Professor Kaplow’s Harvard Law Site here. 

Based on empirical studies, some authors suggest that juries actually perceive the “clear and convincing standard to be greater than the “beyond a reasonable doubt standard.” See Lawrence Solan, Refocusing the Burden of Proof in Criminal Cases: Some Doubt about Reasonable Doubt, 78 Tex L Rev 105, 128-129 (1999). Bench trials, presumably would not present this logical inconsistency but perhaps suffer from judges relaxed assessments of the quantum of proof required for proof “beyond a reasonable doubt.”

If I wanted to belabor this point I would digress into what beyond a reasonable doubt means, but I will avoid that temptation for the sake of the reader.

4. Chuck also quotes the same ILM for the proposition that the IRS's normal tax presumption of correctness would not apply to FBAR penalty determinations because those penalties are not tax penalties. I also avoid a digression, but simply note here that, in my judgment, (i) the presumption of correctness is a meaningless substitute for thought with almost rote case citations giving the appearance of thought and (ii), to the extent that it is meaningful (which I doubt), I am not sure it is limited to actions of the IRS in tax matters, because it had its roots in a general presumption of regularity for government agency action.

5. For persons interested in trying to speculate about the parameters that might be involved in the IRS requests to other Swiss (and other foreign) banks, Chuck offers the following (p. 766):

The disclosure criteria also included (i) 250 accounts in which there is evidence of "fraudulent conduct," such as false documents or the use of calling cards to disguise the source of trading (the threshold for disclosure is 250,000 francs), and (ii) 4,200 accounts that generated revenues of an average of more than 100,000 francs a year for at least three years, including any year between 2001-2008. For purposes of the foregoing, revenues were defined to include gross income (interest and dividends) and capital gains (which are calculated as 50 percent of the gross sales proceeds generated by the accounts during the relevant period). 

Under the disclosure criteria, fraudulent conduct was deemed to exist for offshore company accounts when the UBS records reflected that beneficial owners continued to direct and control, in full or in part, the management and disposition of the assets held in the offshore company account or otherwise disregarded the formalities or substance of the purported corporate ownership (that is, the offshore corporation functioned as a nominee, sham entity, or alter ego of the U.S. beneficial owner) by: 

• making investment decisions contrary to the representations made in the account documentation or regarding the tax forms submitted to the IRS and UBS;

• using calling cards or special mobile phones to disguise the source of trading; 

• using debit or credit cards to enable the beneficial owners to deceptively repatriate or otherwise transfer funds to pay personal expenses or to make routine payments of credit card invoices for personal expenses using assets in the offshore company account; 

• conducting wire transfer activity or other payments from the offshore company's account to accounts in the United States or elsewhere that were held or controlled by the U.S. beneficial owner or a related party with a view to disguising the true source of the person originating those wire transfer payments; 

• using related entities or persons as conduits or nominees to repatriate or otherwise transfer funds in the offshore company's account; or 

• obtaining "loans" to the U.S. beneficial owner or a related party directly from, secured by, or paid by assets in the offshore company's account. 

It is likely that the United States will require other financial institutions to disclose account holders having smaller accounts and less earnings than those at UBS. There have been rumors of discussions regarding the required disclosure of accounts having a high balance of the equivalent of $50,000 at any time between 2002 and 2010. U.S. persons having interests in foreign financial accounts should not find comfort in a belief that other institutions will somehow refrain from disclosing relatively small accounts in the current enforcement environment. Those who think too long may be sorely surprised at the high level of ultimate cooperation between their institution and the U.S. government.

6. Chuck notes (p. 768) that "Practitioners are currently unable to provide any degree of certainty to their clients who have yet to step forward." I will quibble a bit. Practitioners can go through the same drill they have done for many years in assessing a client's risk of criminal prosecution and determining whether to recommend to a client that he or she enter the IRS's historic voluntary disclosure practice. And, if the client chooses to pursue that opportunity, I think the client can get assurance of no criminal prosecution (provided that he or she is not otherwise on the IRS radar screen, which was a disqualifier under the special programs which have now lapsed.  The real uncertainty is with respect to the maximum penalty that would be asserted -- which was capped in the two special offshore voluntary disclosure programs.  Still, one might reasonably speculate that the in lieu of penalty will likely be more than the 25% offered in OVDI 2011 and less than the 50% imposed in criminal cases, with the taxpayer also being subject to the risks of an audit.  (I know, I am speculating that, although the IRS will not have a formal program since it seems to have foreclosed that in OVDI 2011, but it only make sense to me that it will employ the procedures and techniques fine-tuned in the two offshore programs to process future voluntary disclosures under the general voluntary disclosure practice.

7. Chuck has a good discussion of the IRS audit practice relating to foreign accounts and the standard bone-crushing IDR.

Addendum:  I said above that I was not going to deal with presumptions in any detail, but just in case there is at least one masochist among my readers, I offer the following from my Tax Procedure book (footnotes omitted):

General discussion on Presumptions

A related concept is the presumption.  In classic procedure theory, the presumption serves to shift the burden of production to a party who does not otherwise bear the burden of persuasion as to a fact issue.  This classical function for the presumption is codified in FRE 301 as follows.   

Rule 301.  Presumptions in General Civil Actions and Proceedings. 

In all civil actions and proceedings not otherwise provided for by Act of Congress or by these rules, a presumption imposes on the party against whom it is directed the burden of going forward with evidence to rebut or meet the presumption, but does not shift to such party the burden of proof in the sense of the risk of nonpersuasion, which remains throughout the trial upon the party on whom it was originally cast. 

Conceptually, a party who bears the burden of persuasion must produce evidence of the fact in issue in order to persuade.  If no evidence on the critical fact issue is produced, the judge will not permit the jury (the trier of fact in the jury trial paradigm) to decide the fact issue -- that is, the judge will direct a verdict on the fact issue.  Hence, in classic procedure theory, the party bearing the burden of persuasion will necessarily bear the burden of production.  However, for various reasons, the courts (and even Congress) will sometimes impose a production burden to the party who does not bear the burden of persuasion.  We shall see an instance of this in the new burden of proof rules that we shall turn to after this introductory discussion. 

One of the classic debates in procedure theory is whether a presumption that shifts the burden of production to a party who does not bear the burden of persuasion can have any effect beyond merely shifting the burden of production.  That is, whether the presumption has any effect after the party to whom the burden of production is shifted meets the burden of production.  Does the presumption disappear or does it have any continuing effect?  Rule 301 quoted above seems to resolve that issue, but speaks directly to the burden or risk of nonpersuasion.  Is there anything else though that could be influenced by the presumption? 

Let's develop a simple example to illustrate the issue.  Contracting parties A and B provide that legal rights inhere under the contract if A provides B notice.  A mails B notice.  A then brings suit asserting the legal rights.  An essential element of A's case is that A gave B the required notice.  A can prove only that he properly mailed the notice, not that B received it.  There is a presumption that a properly mailed notice is received by the party to whom it was mailed.  Accordingly, this presumption will shift to B the burden of production; if A persuades the trier that A did properly mail the notice, B will then have a burden of production on the issue of whether he received it and, if B does nothing, B loses.  What then happens if B testifies that he did not receive the notice as required for A's case?  B will then have met his production burden.  What then goes to the trier of fact (the jury in the jury trial model)?  What you have is no evidence that B ever received the notice, for all A can prove is that A mailed the notice.  Further, B has denied receiving the notice.  Should that case be submitted to the jury?  The answer is yes, but why is the answer yes if the presumption of receipt has no effect after B has met his burden of production?  The answer is provided in the Conference Committee Report adopting Rule 301 as follows:

a presumption is sufficient to get a party past an adverse party's motion to dismiss made at the end of his case-in-chief. If the adverse party offers no evidence contradicting the presumed fact, the court will instruct the jury that if it finds the basic facts, it may presume the existence of the presumed fact. If the adverse party does offer evidence contradicting the presumed fact, the court cannot instruct the jury that it may presume the existence of the presumed fact from proof of the basic facts. The court may, however, instruct the jury that it may infer the existence of the presumed fact from proof of the basic facts.

Discussion on Presumption of Correctness

Judicial opinions routinely, almost without any thought, pronounce that the notice of deficiency in a Tax Court proceeding has a presumption of correctness.  Similar pronouncements are made in refund cases (the denial of the claim for refund has a presumption of correctness) and in a collection suit (the assessment has a presumption of correctness).  What does the presumption of correctness mean?  I noted above in discussing the general concepts that, under classic theory now embodied in the Federal Rules of Evidence, a presumption serves only to assign a burden of production.  In a tax case, the taxpayer already bears the burden of persuasion as to the underlying tax liability and, since the taxpayer bears the burden of persuasion, the taxpayer perforce already bears the burden of production.  Assigning a presumption of correctness to the IRS’s actions thus assigns to the taxpayer a burden of production that the taxpayer already has by virtue of bearing the burden of persuasion.  Accordingly, one case has said that the presumption of correctness merely covers with a handkerchief something that is already covered by a blanket.  Although conceptually the presumption of correctness has limited and indeed no real function in tax cases where the burden of persuasion is assigned to the taxpayer, the cases seem to have given the presumption a life of its own. 

But the same question is presented in tax cases as noted above in discussing Rule 301, FRE.  That is whether the presumption has some potential effect beyond the mere assignment of burdens of production.  I noted above that Rule 301 as finalized by Congress does permit the trier of fact to "infer" the fact even if it may not preclusively presume it.  In the mail delivery presumption discussed above, based on persuasive evidence that party A mailed the notice the jury would be able to infer that party B received the notice, thereby satisfying A's burden of persuasion.  The jury can simply disbelieve B’s testimony that he did not receive the notice.  Can a trier of fact in a tax case infer that the IRS is correct because of the presumption of correctness said to attach to the notice of deficiency even when the taxpayer has met his burden of production on the issue?  The answer is no.  The reason is that in the mail delivery instance the burden of production for policy reasons is shifted to the party who does not bear the burden of persuasion -- party B.  In the tax case, the presumption of correctness merely assigns to the party who does bear the burden of persuasion a production burden that the party already had anyway.  There is no need to assign any ultimate force to the presumption in assessing whether the taxpayer's burden of persuasion has been met.  If the taxpayer's evidence is persuasive (50+%), the taxpayer wins wholly apart from the presumption of correctness which has then been shown persuasively to be erroneous.

Application to Penalties (This is not in the book at least in this format):

For tax penalty purposes, Section 7491(c) imposes on the IRS a burden of production (a lighter burden than the burden of persuasion.  The IRS meets this burden by producing some reasonable evidence that it is appropriate to impose the relevant penalty, although it need not be evidence that establishes liability for the penalty by a preponderance of the evidence.  If the IRS meets the burden, the taxpayer then has the burden of persuading the Court that he or she is not liable for the penalty. Note that in this discussion there is no need for consideration of a presumption of correctness. 

If, however, the civil fraud penalty is involved, the IRS does bear a persuasion burden.  Section 6663(a)(1).  The IRS is first required to prove that some portion of the understatement is attributable to fraud by clear and convincing evidence. If the IRS meets that burden, which is a substantial burden lying somewhere between more likely than not and beyond a reasonable doubt, the entire understatement will be subject to the penalty except to the extent that the taxpayer establishes by a preponderance of the evidence that it does not arise from fraud.  § 6663(b).   

Now note, in this discussion, there is no office for any presumption of correctness. 

That is the bare outline of my case for the point that presumption of correctness does nothing.  I could say even more on this without some of it not being repetitive but discretion tells me, first, that I have said too much already and, second, that I must quit when I am not as far behind as I could be.